Tag Archives: AAPL undervalued

Recently I have been trying to dig deeper into Apple (AAPL) to get a handle on what the near term may mean for this amazing company and thereby get an insight into APPL’s valuation. I have struggled with AAPL’s valuation in previous posts (here and here) but after each of my musings the share price continued on its upward trajectory.

Irrespective of whether iPhone 8 and iPhone X unit sales disappoint (due to unit shortages or otherwise) over the coming months, it seems highly probable to me that Apple will be successful in segmenting their iPhone market further over the medium term and break through the $1000 per iPhone spend in a significant way. Their R&D spend of over $10 billion (including nearly $2 billion of share options) goes a long way to ensuring customers will pay for their innovations.

The reason why AAPL are following the current strategy is a hot topic of debate with analysts. Some see the new iPhone models feed into a super-cycle of updates and continued installed base growth, pointing to the approximate 40% of the current iPhone installed base older than 2 years. Other analysts believe that the smartphone market has plateaued (see graph from Mary Meeker below) and Apple is embarking upon a segmentation strategy to harvest their loyal customer base.

click to enlarge

The estimates for the iPhone installed base vary significantly across analysts from 550 to 750 million units and some, such as Deutsche Bank and BoA ML further, break the base down to core and secondary non-core users. Although most of the estimates are likely out of date as they were published prior to the iPhone 8 and iPhone X announcements, the graphic below illustrates the differing views.

click to enlarge

It is likely no surprise that I am in the plateau camp on future growth of the installed base. I have assumed an installed base of 640 million as at end September 2017 and 40% or approximately 250 million of these are potential iPhones upgraders with phones older than 2 years. I have further assumed that a proportion of the installed base, I selected 10%, are secondary non-core users with a very low propensity to upgrade. That leaves an approximate 190 million potential upgrades for the FY2018. Despite the lack of growth of the market, I assumed another 10 million sales from new purchasers giving a target iPhone unit sales of 200 million for FY2018. 200 million of annual unit iPhone sales is well below most analyst estimates which average around 240 -260 million for FY2018.

Of the 200 million iPhone unit sales for FY2018, I have further assumed 45 million are iPhone X and just over half are iPhone 8, with the remainder being iPhone 7 and older models. For Q42017, I am assuming only 9 million iPhone 8 sales with 35 million of iPhone 7 and older models (influenced by the amount of inventory clearance sales I have seen in retail stores). The graph below shows my installed base assumptions, with my estimates for sales of the iPhone 8, iPhone X and it successor models over FY 2018 and FY2019 (I am assuming 200 million units is the new normal for annual iPhone sales through to FY2020).

click to enlarge

The resulting average selling price (ASP) for FY2018 is $785 with annual FY2018 revenues from iPhone of $157 billion. For FY2019, I have assumed a ASP of $860 with annual FY2019 iPhone revenues of $172 billion. The graph below shows my revenue assumptions over FY 2018 and FY2019 across all products.

click to enlarge

The EPS estimates coming out of my model, using the assumptions above (amongst others), for FY2018, FY2019 and FY2020 are $10.17, $11.45 and $11.81 respectively (I agree with the estimates of $9.00 for FY2017). That represents 13% EPS growth for 2018 and 2019, slowing to 3% in 2020. At the current share price of $160, the forward PE (excluding cash) would look as per the graph below.

click to enlarge

My analysis suggests that AAPL either deserves a higher multiple than the recent past to justify its current value or it will have to convince enough new iPhone users to buy its new products to take market share from its competitors and sell more than 200 million iPhone annually for the foreseeable future.

Given the potential headwinds for iPhone 8 and iPhone X over the short term, the current price may be difficult to defend near term as the market gets used to lower iPhone sales at higher prices (and hopefully margins too). Then again, going negative on AAPL hasn’t proven fruitful in the past and the analysts are currently hyping up AAPL’s prospects with price targets heading solidly towards $200.

Given my previous history of questioning AAPL’s valuation, maybe indecision is the best answer for the time being……

You have to give credit where it’s due. AAPL’s Q1 2015 quarter shows the awesome strength of its business model with sales of over 75 million of its flagship iPhone as the impact of its latest product upgrade shines through. The graphs below show revenues by region and by product using their new reporting segments.

click to enlarge

click to enlarge

These results illustrate the folly in trying to make projections for Apple past a few quarters (as I attempted to do previously in posts like this). As analysts scramble to update their targets, I wanted to get a feel for what an AAPL price of $120 looked like in terms of historical and the current forward PE (excluding net cash). Using my estimates for EPS over the next 7 quarters and the average analyst estimate, the current price around $120 looks reasonable, as the graph below shows.

click to enlarge

Anything significantly above the current price assumes that Apple’s awesomeness will continue over the next 2 years. There is little doubt that Tim Cook has now stepped out of Steve Job’s shadow. The next tests will be the launch of the Watch and the development of iPay. Continuing the awesomeness beyond the current iPhone upgrade cycle maybe too big an ask, even for Cook. Then again, based upon the recent results and my track record on AAPL, what do I know……

Sentiment plays a massive role in Apple’s market value. This time last year, the market was fretting about AAPL’s over-reliance on the iPhone in a maturing smartphone market, declining gross margins, and a lack of visibility into new product categories.

AAPL’s success in China, the stabilisation in gross margins and its increasing shareholder friendly buy-back/dividend policy have overcome many market apprehensions. Although the iPhone’s global market share is down to approx 15% after competitors gained most from the over 30% growth in global smartphones sales, AAPL shares have gained over 12% after the latest quarterly results on strong iPhone sales of almost 44 million units (17% year on year iPhone growth).

The much speculated iWatch (or similar wearable type orientated towards the health conscious device) doesn’t now look likely to be launched until late 2014 or early 2015. The Q2 sales of iPads were also well below expectations. Notwithstanding these issues, it is the forthcoming refresh of the iPhone product line (i.e. iPhone 6), which may include bigger screen options, that has some analysts excited. Morgan Stanley recently published the graphic below to highlight the upgrade potential in the US.

click to enlarge

I have posted before (here and here) on AAPL’s valuation but the lack of visibility into Apple’s trajectory is reflected in my lack of conviction on the stock. I do however think that Apple is a fascinating investment case study and worthy of some analysis. My previous attempts at some basic DCF valuation selected projections based upon my assumptions of the future.

This time, I wanted to take a stab at projecting figures which I believe are reflected in the current (more optimistic) market thinking. For example, I have assumed that Apple can broadly maintain its current gross margins across its products in the future. I have also assumed that a new wearable product, let’s call it the iWatch for convenience, would be available from 2015 and would track the iPhone user base (starting at 20% in 2015 or 35 million units and growing by 5% of the iPhone user base a year thereafter). I have assumed a $300 retail price for the iWatch and a 30% gross margin. The projections for all unit sales are represented in the graph below.

click to enlarge

The associated revenue projections, assuming moderate unit price declines of between 1% and 2% per annum depending upon the product, are therefore as per the graph below

click to enlarge

Keeping all other major financial assumptions at the current levels (for example, SG&A and R&D as a percentage of revenue, cash-flow generation, etc.) and, assuming an approximate assumed market discount (risk) rate of around 7% and a termination multiple of 5 times the 2023 PV cash-flow, the exhibit below shows how a $600 AAPL share price could be justified using a basic DCF valuation. The PE ratios are based off average analysts EPS estimates for 2014 from Yahoo finance.

click to enlarge

The question therefore is whether the unit sale projections, and to a lessor degree the other assumptions, above are a reasonable basis for investing? As stated earlier, my conviction on Apple is not high enough to answer that question. Is yours?

Disclaimer

This blog represents my personal views and is not reflective of the views or opinions held by any company or employer I work for currently or have worked for in the past. The views expressed herein are based solely upon publicly available data. No views expressed herein should be taken as an endorsement to take any particular course of action in the markets. The basis of this blog is that different views should be expressed and readers make up their own minds on the what they believe and act accordingly.